3/19/2001 @ 12:00AM

The new face of Swedish socialism

Swedish snapshot A: Shows a taxed-to-the-eyeballs welfare state where the government grabs more than 52% of the country’s GDPthe highest percentage of any industrial country. A Swedish businessman who earns Euro200,000 a year gets to keep just 49% of his paycheck. Of OECD countries, only France comes close to Sweden in taxing its most successful businesspeople (for complete tax data on 33 countries, see “The tax grab 2001,” Forbes Global, Feb. 5).

Swedish snapshot B: Shows a booming economy bubbling with entrepreneurial activity. Growth is predicted to be 3.5% for 2001; inflation, 1.7%; unemployment, 4% (less than half the European average). In 1999, according to the European Information Technology Observatory, Sweden ranked first in the world in investment in information technology and telecommunications. Venture capital is pouring into Sweden, and labor productivity is rocketing: From 1990 to 1999 productivity climbed 47% in Sweden, against 39% in the U.S. and 31% (on average) in the EU. Last year, Sweden topped the global standings in R&D spending as a percentage of GDP with 3.7% (in the U.S. it was 3.1%), according to the OECD.

How to reconcile snapshots A and B? Is Sweden a bloated welfare state? Or a People’s Republic of Entrepreneurs?

The answer is that it’s a mixture of both. But the entrepreneurial part of the mix is rapidly gaining ascendancy. One yardstick is the number of business startups. They averaged 29,000 a year between 1984 and 1989 and 36,000 between 1994 and 1999, an increase of nearly 25%.

Cradle-to-grave security is the rule in Sweden, and has been since the early 1950s (the country went socialist in 1932). Go on the dole in Sweden, for example, and you can get 80% of your last job’s pay for at least five years. Like to fish? The government will put you in a twelve-month program to learn how to be a fishing guide. Health care is free. So is education. Hence those obscenely high taxes.

Less well known, however, is that starting in the early 1990s, Sweden finally woke up to the fact that to be successful, a country needs entrepreneurs. No entrepreneurs, no new businesses. No new businesses, rising unemployment. Rising unemployment, politicians looking for new jobsor new careers. Deciding that they like their jobs, a new generation of Swedish Social Democrats has created a much more friendly environment for business. Sweden is not a capitalistic heaven on earth, but it’s not the hell on earth for entrepreneurs that it was until a few years ago.

Consider the distance Sweden has traveled. After some flush years in the 1950s and 1960s (the result, according to Milton Friedman, the Nobel winning economist, of Sweden’s “having had the good economic sense to stay out of World War II”), the socialists neutered then exiled the geese that laid the golden eggs. Ingvar Kamprad, 75, the founder of ikea, the $10 billion (estimated worldwide 2000 revenues) furniture retailing chain, describes meetings with Sweden’s tax bureaucrats in the 1960s and 1970s this way: “They would accuse me: But you just want a profit.’ And I would proudly reply that I was giving people jobs.”

Bertil Hult, 60, the founder of the Stockholm-based ef language schools, remembers those dark days well. “By the 1970s, the Swedish media were presenting anyone who started a business as someone who was using the people,” he says. “Entrepreneurs were pariahs. So lots of entrepreneurs left. The government’s view was, Let them go, we don’t need them here.’” In the 1970s Hult left and built ef from Germany, the U.K. and the U.S. Today the privately owned ef Group is the largest company of its kind in the world. Veckans Affärer, a respected Swedish business magazine, estimates that its revenues are $650 million; its net margin is 5%; and its payroll is 17,000.

With entrepreneurs like Hult fleeing, the economy began going down the tubes. Growth slowed, and inflation rose. State spending and debt soared. Private-sector jobs began to disappear.

By 1991 the voters had had enough. They threw out the Social Democrats for the first time since the war and installed Carl Bildt’s Conservative government. Bildt set about liberalizing important state-monopolized or dominated markets, notably telecommunications and banking. As competition in telecoms cut telephone and internet access charges, Sweden became a hotbed of technology experimentation, with some of the highest penetration rates for mobile phones and internet access.

Probably most important, Bildt cut back Sweden’s confiscatory taxes. His 1991 tax reform package capped national taxes on personal income at about 50%; before 1991, rates could go above 90%. Bildt’s tax reform also established capital gains, dividend and net interest income as special income categories, taxable at 30%. Corporate income tax: 28%.

The tax cuts and closing of loopholes brought with them temporary pain. So in 1994, out went Bildt and back came the Social Democrats, led by Ingvar Carlsson. Carlsson chose for his finance minister a moon-faced, tough-minded politican named Göran Persson. Persson’s message: The party was over. Bildt’s tax cuts and privatizations would stay. The government must balance its books and lower social spending.

In 1996 Persson succeeded Carlsson. He retained Bildt’s reforms, cut government spending and added some tax incentives. Magnus Wilfors, a partner at the Malmö office of Ohrlings PricewaterhouseCoopers, says: “Although the rest of the world doesn’t seem to know this, the tax burden on entrepreneurs [in Sweden] has eased substantially [since 1991].”

Sensing a new mood in his native country, Hult returned in 1992 (but not before setting up a family trust). His opinion of the place now? “Sweden is not such a bad country for an entrepreneur to live in these days,” he replies. “For example, personal income tax rates are high, but if you live off capital gains, which are taxed at a bearable rate, you can do very well.” What accounts for the change? Says Hult: “I believe the politicians have noticed that half of the U.S. workforce works for under-100 employee companies and 25% work for companies with fewer than than 20 employees. So now they want startups in Sweden.”

One of the best ways for a mature economy to rejuvenate itself is to open its borders to upwardly mobile immigrants from poorer countries. Sweden has learned this trick. Walk the streets of any Swedish city and it’s clear that the country is far less homogeneous, much more diverse, than it was just a decade ago. Last year, one of five new businesses was started by immigrants. The newcomers, most of them from the Balkans and Mideast, work hard, make money and harbor grander ambitions for their children.

The young woman in the photo on page 34 is a good example of the new business breed. She’s Soki Choi, 27, born in Sweden to South Korean parents who came to Sweden so that her father could take a Ph.D. in international law. The Chois decided to stay: Choi Senior dropped international law to promote Korean art and literature in Europe.

Soki Choi had planned on a career as a concert pianist but decided that she could be more creative in business. Graduating in 1996 from the prestigious Stockholm School of Economics, she worked for a couple of years at Andersen Consulting. At the end of 1999 Choi started BlueFactory, a Stockholm-based company that produces wireless entertainment software and games. Choi raised $3.5 million in first-round financing in April and is now in the middle of round two. Money is hard to come by, but Choi exudes optimism. “Our end-user numbers have been doubling every month recently,” Choi says enthusiastically, “and I’m very confident that we’ll succeed with round two financing.”

Well-educated and fluent in Swedish, English and Korean, Choi could have started BlueFactory in Cambridge or Silicon Valley. Why Sweden? Well, because it’s her home, but also because that’s where so much of the entrepreneurial action is. “Everyone I’d been to school with seemed to be involved in some sort of startup, and I knew I had a good idea,” says Choi.

BlueFactory provides a range of entertainment software, primarily to network operators. Products include Catch the Robber, an adventure game set in Stockholm’s Old Town, and Flirtylizer, a wireless dating service with positioning. At the 3GSM World Congress, held in Cannes at the end of February, BlueFactory introduced the first mobile-entertainment application based on the hot, new bluetooth standard.

To succeed, entrepreneurs like Choi need money. No problem here. From 1995 to 1999, venture capital and private equity investment in Sweden rose 201% annually, against 40% in the U.S. and 39% in the U.K.

Money isn’t everything. Entrepreneurs also need other entrepreneurs and well-educated workers. This used to be a serious problem for Sweden. Listen to Robert Af Jochnick, 60, the cofounder and chairman of Oriflame, a $500 million (revenues) direct-sales cosmetics company. “When we started our business in 1967, there were hardly any entrepreneurs to be found,”says Af Jochnick. “Today’s Sweden can support entrepreneurial activity.”

Soki Choi had no difficulties staffing her startup. John Wennerstrom, 27, BlueFactory’s chief technology officer, once had his own IT company; Per Holmkvist, 32, the creative director, worked for Ericsson in China. Both came from Andersen Consulting. Linda Samlin, 27, BlueFactory’s cfo, was a classmate of Choi’s at business school. BlueFactory now employs 21 people. Isn’t she discouraged by Sweden’s high personal income taxes? “A lot of us aren’t really in it for the money,” she explains. “The kick, the joy is in the project, in working with a great peer group, in getting the job done in a new way.”

Who gets credit for Sweden’s economic renaissance? Well, the Persson government claims a big share. “The economic conditions we’ve created have stimulated this revival,” maintains Bosse Ringholm, the minister of finance, in a conversation with Forbes Global. Ringholm cites among other things the success that he and his predecessor, Erik Asbrink, have had in cutting national debt from more than 80% of GDP to 60%.

Leif Pagrotsky, Sweden’s bright and engaging trade minister (and a close confidant of Persson), nods in agreement:”Does it seem fair to you to conclude that all this has happened in spite of the government?”

But Johan Stael von Holstein, the founder of Icon MediaLab, a $54 million (market cap) website-design company, gives the government “zero points” for the current entrepreneurial burst. Now working for Icon MediaLab in Singapore, Holstein says that the burst results from the global spread of new technology, and new attitudes toward business in Sweden. “Once the socialists came to power they made a dirty word out of entrepreneur,” says Holstein. “But after Swedish kids started traveling and saw the outside world, a lot of them woke up and decided that they didn’t have to listen to politicians.”

Jonas Tilly, 35, doesn’t think much of the socialists, either. The founder of Tilly Medical Products, based in Lund’s Ideon science park, Tilly has just come up with a product that has attracted great interest from venture capitalists. He vows: “If I achieve some real success, I’m going to think about a tax jurisdiction that will let me accumulate some real wealth.”

Mark this well: Sweden will not dismantle the welfare state, and the government will continue to frustrate market forces. “Do you know why we have good work force mobility in Sweden?” asks Pagrotsky. “Why you can close a plant here in a way that you can’t in southern Europe? It’s because our costly social [safety] net protects laid-off workers and trains them for new jobs. What we do saves everyone money and generates more money for the society at large.”

Likely to remain on the books, at least for the next few years, is Sweden’s odious wealth tax, which imposes a 1.5% annual levy on an unmarried individual’s net assets in excess of Euro101,000including the value of shares publicly traded on Stockholm’s main market (the so-called A-List). But there are loopholes. The wealth tax does not apply either to unlisted shares or to shares of smaller companies, those that don’t trade on the A-List. And since 1998 even A-List shares escape the wealth tax if they are used by the owner to maintain control of a listed company.

Sweden’s marginal income tax rate (federal plus local) on an annual salary of Euro50,000 is 55%. Compare Germany, where Chancellor Gerhard Schröder’s new tax reforms have cut the marginal rate on a Euro50,000 salary to just 34%. But competitive tax cutting is beginning to sweep through Europe, and the Swedes will not be able to resist the tide.

Kai Hammerich, a former vice president of Saab who now heads Invest in Sweden, a semiautonomous official agency that sponsors foreign investment, notes a recent measure under which foreign executives in Sweden are allowed to exclude 25% of their income from taxation. “And I think that broader tax relief may be coming,” says Hammerich. Ringholm tells Forbes Global that the Persson government has plans to reduce Sweden’s world-leading 52% tax/GDP ratio by “about a percentage point of GDP each year.” Indeed, the figure was more than 53% in 1999, and public spending continues to fall, to 54% of GDP this year from more than 58% in 1999.

A growing number of global investors believe that Sweden has built momentum likely to carry it strongly in the years immediately ahead.From 1995 to 1999, foreign direct investment into Sweden averaged $22 billion a year, a figure that, when adjusted for population differences, was the highest in the world.

Brian Larcombe sees potential in Sweden. Larcombe is the CEO of 3i in London, an $12 billion (market cap) venture capital and private-equity investment house. In mid-February, 3i announced that it and a partner would pay $850 million for Atle, a Swedish private-equity operation. “We see Sweden as a strong business environment with an unusually international outlook,” says a 3i spokesperson. “And of course the Swedish it environment is almost unmatched.”

Encouraging entrepreneurs while maintaining a socialist facade is not an easy trick to pull off. But investors seem to believe that the Swedes can do it, and Pagrotsky is certain it can be done. “Forget all the doctrinal disputes,” he urges. “I argue that capitalism can thrive in a social-democratic environment. If that’s heresy, you can burn me at the stake.”